Beginning Assets for Individual Investor

It seems to me, that to calc the req return, you always need to calc ongoing cash flow needs (living expenses) and the beginning assets.

One frustrating thing I have encountered is that sometimes the first years living expenses are subtracted from beginning assets and sometimes they are not.

Any guidance on what the rule of thumb here should be?


if they have an immediate liquidity need, you subtract from the asset base (i…e the denominator of your calc).

but living expenses for the upcoming year are not subtracted.

for example, if the portfolio is 5M today, and they need to make a lump sum payment for a child’s wedding today of 100k, and next year’s expenses, which increase with inflation, are 200K, and inflation is 3%, the calc would be:

(200,000)(1.03) / (5,000,000 - 100,000)

then add 3% at the end if they say they want to maintain the real value of the portfolio.

so what you have done is calculated next year’s living expenses, an divided it by today’s portfolio less any immediate liquiidity needs (since the 100,000 for the wedding cant be used over the course of the upcoming year to generate returns).

But I do believe that current year living expenses / living expenses shortfalls (not covered by current income) are subtracted from the beginning asset base. I do not think your example above is correct.

See Q1, 2007 test, Ingram case where the first years living expenses are subtracted from the beginning asset base.

I think living expenses are not subtracted from the beginning asset base only when ongoing current income is sufficient to cover them, see Q1 2008, Carvalho case.

i havent done 2008 yet but i did do 2007 recently.

we subtracted the 200K because it said they want to make their first distribution immediately. that means today.

so it must be removed from the asset base, as it cannnot be used to generate returns over the coming year.

Nice call - didn’t notice the specification for the immeadiete distribution. I’ll try to find a better example…

yes. please do. IPS is my achilles heel, so the more practice the better especially with funky things.

Im going to hi-jack this thread because it reminded me of a similar issue. When the IPS states a certain funding requirement is needed in one year (in addition to ongoing expenses, so lets say they are buying a boat or something) … I have seen two different approaches.

One approach, they simply state this in the liquidity section – IE “bob should keep a portion of his assets in liquid securities to meet the planeed outflow at the end of the year”. The return requirement does not adjust the asset base, as it is simply assumed that the return takes into account a portion of those portfolio assets are in t-bills for the coming expenditure.

In the other example, they use the risk-free rate and PV the planned outflow in one year back to today, and remove that from the investable asset base, then they calculate required return. This also goes for questions that state a desired safety fund of say 3-6 months salary. Sometimes they just state to put it in tbills, sometimes they PV 3 to 6 months salary and deduct from asset base.

Thoughts on when to use each?

markCFAIL, I have the exact same question. I’m hoping that they are clear and use words like “immediate” (remove from asset base) vs. “in the near future” (list as liquidity requirement)

even I had this question because of which I logged in to AF. As per the example of the show NY, do we just take the ongoing exps in the numerator or we also take the 100,000 required for child’s wedding. That is also a required expenditure right which needs to be met by the portfolio?

I recall this fact pattern somewhere (asset allocation?) but can’t seem to,locate it.

Hank - Example 9 - Pg 261-264 while recalculating the revised Real Estate Allocation after doing the Corner Portfolio weighted asset allocation.

This is my question: If next year’s expenses are 200,000 then why would you multiply expenses by 1.03? it is already “next year’s” expense figure. I would have just used 200,000/4,900,000 + 3%

I actually came across a similar question to this over the weekend where they asked for next year’s required return and gave 2 expenses: #1 actual estimated college costs for the next year and #2 the current year’s expenses. I adjusted the expenses for inflation to get next year’s, but the estimated costs for college I did not adjust because the problem stated they were the expected costs in the next year. To me that says they should not be adjusted.

This was a question in schwesser book 1 morning test 2, I believe question 7. Anyone have any input or thoughts?

if next year’s expenses are 200K - it need not be adjusted for Inflation. However if they provide this year’s expenses and then ask to get to next year’s (or first year after retirement) required return – then it needs to be pushed up for Inflation.

Look at the 2011 Individual question.

Current Year Living Expenses = 250,000

Net Investable Assets:

  1. Start Investment Portfolio = 8.000 - 3.5 (Pay off mortgage balance) - 0.15 (Pay off debt)= 4.35 Million $

Current year:

  • Inflows: Salary = 475 K
  • Outflows: Living Expenses = 250 K + Mortgage Payment = 225 K = Net 475 K

Inflows and Outflows in current year are a wash.

So Investment portfolio remains at 4.35 Mill $.

next year:

  • Inflows = 48 K (After tax)
  • Outflows = 250 K * 1.03 = 257.5 K
  • Net outflows = 209.5 K
  • Required Return = 209,500 / 435,000,000 = 4.82%
  • Required Return Nominal After tax : 1.0482 * 1.03 - 1 = 7.96%

I agree, but just to clarify:

If expected costs for 1st year in college are 50,000 and this years expenses were 150,000; with an asset base of 5million & inflation at 3%, what is the required return for next year (the 1st year in college)?

Would you calculate this as:

  1. [50,000 + (150,000*1.03)] / 5million = 4.09%


  1. [(50,000 + 150,000)*1.03] / 5million = 4.12%

as (1)…

(1.0409)(1.03) to maintain purchasing power of portfolio :slight_smile: